Do you ever worry about how your beneficiaries will manage their portion of their inheritance when you pass away? One solution that allows you to still exert some control over your money—even after passing—is with a revocable living trust (RLT).
- A revocable living trust is a trust document created by an individual that can be changed over time.
- Revocable living trusts are used to avoid probate and to protect the privacy of the trust owner and beneficiaries of the trust as well as minimize estate taxes.
- Revocable trusts, however, have several limitations including the expense to have them written up, and they lack features of an irrevocable trust.
- Revocable trusts differ from irrevocable trusts in that the grantor still retains ownership of assets and can more easily change beneficiaries.
- Revocable trusts differ from wills in that wills are more useful and cheaper for simpler estates, though wills do not offer the same level of privacy protection.
How to Establish a Revocable Living Trust
A revocable living trust is like a rule book for how your assets are to be handled when you die. Once your assets belong to the trust, they do not have to go through the probate process upon your death. As long as you're a competent adult, you can establish a revocable living trust. This is done in three steps.
- Establish a written agreement or declaration that appoints a trustee to manage and administer the property of the grantor (you).
- Name a competent adult, bank, or trust company as your trustee. You can also act as trustee throughout your lifetime.
- Place your assets—including investments, bank accounts, and real estate—into the trust.
At this point you no longer own those assets; they belong to the trust. However, as this is a revocable living trust, you retain control of the assets, even though they no longer belong to you, while you're alive.
You can amend or change the trust at any time. Income earned by the trust's assets goes to you and is taxable, but the assets themselves do not transfer from the trust to your beneficiaries until your demise.
Revocable Trust vs. Irrevocable Living Trust
The obvious difference between a revocable living trust and an irrevocable living trust is that the revocable trust can be changed or voided when you want. You still remain as the trustee, so you can make changes and update decisions as you see fit. For example, if you wish to change a beneficiary after a revocable living trust has been set up, you may do so.
On the other hand, an irrevocable living trust limits what can be done once the trust is established. Often, you can not modify or change the trust without approval from everyone listed in the trust. To make the change, beneficiaries may also be required to provide their signature approval.
Another large difference between the two types of trusts are the associated trust taxes. In a revocable trust, the assets within the trust are still yours. You are still responsible for any taxes on income that results from assets within the trust; these taxes are reported on your personal tax return. This is different than a irrevocable trust where the assets no longer belong to you. Any taxes due on trust assets are applicable to the trust.
Assets within a revocable trust may also be subject to bankruptcy judgments since the assets are still owned by the individual. Assets in an irrevocable trust are shielded by the grantor's creditors.
Revocable Trust vs. Will
Although a living trust offers many of the same coverages as a will, the two legal items do cover different periods of the grantor's life. A revocable living trust covers an individual's assets while they are alive, when they are incapacitated, and when they are deceased. A living will only covers the individual's assets after they have passed away.
Living trusts also have the added benefit of avoiding probate court. Living wills may result in a court dispute. In addition, a living will become public record, and there is minimal privacy regarding the distribution of assets. With a living trust, there is a greater degree of privacy.
When drafting a living trust, you must specify a trust administrator to oversee the trust until minors under the age of 18 are old enough to receive their inheritance. On the other hand, individuals under the age of 18 can be named to directly receive assets. In addition, wills are usually easier and cheaper to create a swell.
An oversimplification of the two options is that a will is better for more basic estates while a trust is better for more complex estates.
Advantages of the Living Trust
Avoiding probate is the main advantage of establishing a living trust, but other benefits like privacy protection and flexibility make it a smart choice.
Avoidance of Probate
Probate is the legal process for transferring your property when you die. It requires presenting documents to a probate court and going through a multi-step process—or processes if you have assets or property in different states.
Establishing an RLT avoids expensive probate proceedings, allowing assets to be transmitted to beneficiaries faster. Assets named in a trust bypass the costly courts and typically take precedence over the property designated in your will.
Changeable and Flexible
The living trust allows you to make changes (or amendments) to the trust document while you are still alive, at your own discretion.
Revocable trusts are a good choice for those concerned with keeping records and information about assets private after your death. The probate process that wills are subjected to can make your estate an open book since documents entered into it become public record, available for anyone to access.
Eliminate Challenges to the Estate
The standard may create family disputes at your death and be challenged for alteration by any member of your family. By using a trust, you can specifically disinherit anyone who posts a challenge to your wishes upon your death.
Segregation of Assets
This is useful for married couples with substantial separate property that was acquired prior to the marriage. The trust can help segregate those assets from their community property assets.
Assignment of Durable Power of Attorney/Guardianship
A living trust can be used to help control a guardian's spending habits for the benefit of your minor children. It can also authorize another person to act on your behalf if you become incapacitated and need someone to make decisions for you. Should you become impaired or disabled, the trust can automatically appoint your trustee to oversee it and your financial affairs with no requirement to obtain durable power of attorney.
This allows the wealth that you've accumulated to continue to grow for multiple generations by using a professional trustee to manage your property. You can limit the number of withdrawals to income only, with special emergency provisions if you wish.
Estate Tax Minimization
While the RLT is not a good tax minimization tool on its own, provisions can be included in the trust documentation to transfer wealth by establishing a credit shelter trust in the event of your death. The CST is a very effective tool to help reduce estate taxes for large estates that exceed the combined estate tax exclusion amounts.
Disadvantages of the Living Trust
While there are many advantages to establishing a revocable living trust, there are also some drawbacks.
Expense of Planning
Establishing a trust requires serious legal help, which is not inexpensive, but the price will likely vary depending on where you live.
Maintaining Trust Books and Records
And once you create the trust, your work isn’t done. Most people need to monitor it on an annual basis and make adjustments as needed (trusts do not adapt automatically to changed circumstances, such as divorce or the birth of a child). You should consider the added inconvenience of making sure that future assets are continuously registered to the trust and providing other professionals with access to the trust documents to review trustee powers and duties.
Re-Titling of Property
Once the trust is established, property must be re-titled in the name of the trust. This requires additional time, and sometimes fees apply to processing title changes.
Minimal Asset Protection
Contrary to popular belief, revocable living trusts offer very little asset protection if you retain an ownership interest, such as naming yourself as trustee.
Expect to contend with additional professional fees such as investment advisory and trustee fees if you appoint a bank or trust company as the trustee.
No Tax Break
For all your hard work, you will not receive a tax benefit from a revocable trust. Your assets in the trust will continue to incur taxes on their gains or income and be subject to creditors and legal action.
Hassles such as problems with title insurance, Subchapter S stock and real estate in other countries can create a whole host of new issues. More problems can crop up if you fail to adequately educate your spouse on the terms and purpose of the trust.
Avoids potentially expensive probate process
Allows for a decedent to have greater privacy over the treatment of assets
May result in greater long-term management of assets and wealth continuity
May reduce or minimize estate taxes through specific provisions
Results in additional administration and upkeep expenses
Requires continual (at least annual) review of plan
Does not minimize taxes on its own
May result in administrative difficulties for unique assets
Who Owns the Property in a Revocable Living Trust?
In a revocable living trust, the grantor still owns their assets and are responsible for reporting and associated taxes on their personal return. This is different for an irrevocable living trust where the assets are no longer owned by the individual.
Is a Trust Better Than a Will?
A trust is a more complex, expensive plan for a beneficiary's assets that may provide a plan during the person's life prior to when they pass away. For individuals who do not have many assets or do not have a complicated plan for distributing their assets after they pass, a will may often suffice for their needs. For larger estates with more complicated granting requirements, a trust is likely more advisable.
What Assets Can Not Be Placed in a Trust?
There are several assets that cannot be placed in a trust. Retirement assets, health saving account balances, assets held in other countries, vehicles, or cash are some assets that are excluded.
Why Do People Set Up a Trust?
Similar to a will, a trust outlines the way an individual wants their assets managed during their life, during periods of incapacitation, and after their passing. A trust is used to ensure heirs rightfully get assets in accordance with the grantor's wishes. It is also used to potentially minimize taxes, avoid probate costs, and increase the privacy around the distribution of assets.
The Bottom Line
Compared to wills, revocable trusts provide increased privacy as well as more control and flexibility over asset distribution. With a revocable living trust, you do most of the work upfront, making the disposition of your estate easier and faster. But they also require substantially more effort and higher costs. As with any major legal issue, you should consult with a trusted professional, in this case, someone well versed in estate planning, before embarking on a project of this magnitude.